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Bureau of Mines Information Circular/1982 



The Depletion Allowance and Domestic 
Minerals Availability 

A Case Study in Copper 



By Paul R. Thomas, Robert L. Davidoff, 
and Melinda M. Quinn 




UNITED STATES DEPARTMENT OF THE INTERIOR 



Information Circular 8874 



The Depletion Allowance and Domestic 
Minerals Availability 

A Case Study in Copper 



By Paul R. Thomas, Robert L. Davidoff, 
and Melinda M. Quinn 




UNITED STATES DEPARTMENT OF THE INTERIOR 
James G. Watt, Secretary 

BUREAU OF MINES 
Robert C. Horton, Director 






As the Nation's principal conservation agency, the Department of the Interior 
has responsibility for most of our nationally owned public lands and natural 
resources. This includes fostering the wisest use of our land and water re- 
sources, protecting our fish and wildlife, preserving the environmental and 
cultural values of our national parks and historical places, and providing for 
the enjoyment of life through outdoor recreation. The Department assesses 
our energy and mineral resources and works to assure that their development is 
in the best interests of all our people. The Department also has a major re- 
sponsibility for American Indian reservation communities and for people who 
live in Island Territories under U.S. administration. 




This publication has been cataloged as follows: 



Thomas, Paul R 

The depletion allowance and domestic minerals availability: 
a case study in copper. 

(Information circular ; 8874) 

Supt. of Docs, no.: I 28.27:8874. 

1. Copper industry and trade— Government policy— United States. 
2. Depletion allowances— United Spates— Case studies. I. Davidoff, 
Robert L. II. Quinn, Melinda M. III. Title. IV, Series: Information 
circular (United States. Bureau of Mines) ; 8874. 

TN295.U4 622s [336.24'316] 81-607164 [HD9539.C7U5] AACR2 



For sale by the Superintendent of Documents, U.S. Government Printing Office 

Washington, D.C. 20402 



1 

■ 



^ PREFACE 

A. 



V 



The purpose of the Bureau of Mines Minerals Availability program is to assess 
the worldwide availability of nonfuel minerals. The program identifies, collects, 
compiles, and evaluates information on active, developed, and explored mines and 
deposits and on mineral processing plants worldwide. Objectives are to classify 
domestic and foreign resources, to identify by cost evaluation resources that are 
reserves, and to prepare analyses of mineral availabilities. 

This report is part of a continuing series of Minerals Availability System (MAS) 
reports to analyze the availability of minerals from domestic and foreign sources 
and the factors that affect availability. Questions about the MAS program should 
be addressed to Director, Division of Minerals Availability, Bureau of Mines, 2401 E 
Street, N.W., Washington, D.C. 20241. 










CONTENTS 

Page Page 

Preface iii Quantifying the total depletion deduction and 

1 Federal income tax expense 6 

Abstract Measuring the weighted average total cost 

of production 8 

Introduction ^ Copper price and availability 9 

Mineral tax analysis employing the MAS supply The income limitation and the minimum Federal 

analysis model (SAM) 2 tax 12 

The depletion allowance: Changingthe statutory percentage depletion 

rationale and operation 3 rate on copper 13 

Domestic copper availability base case analysis . . 4 Conclusions 14 

Repealing the percentage depletion allowance .... 6 References 15 



ILLUSTRATIONS 



1. Potential total copper production from currently producing properties at various prices and 

rates of return — base case 5 

2. Potential total copper production from nonproducing properties at various prices and 

rates of return — base case 5 

3. Potential total copper production from producing and nonproducing properties at various prices 

(evaluated at 15- and 18-percent rates of return, respectively) — base case 6 

4. Potential annual copper production from producing and nonproducing properties in selected 

years — base case ? 

5. Potential total copper production from currently producing properties at various prices and 

rates of return — no percentage depletion 9 

6. Potential total copper production from nonproducing properties at various prices and 

rates of return — no percentage depletion 10 

7. Potential total copper production from producing and nonproducing properties at various prices 

(evaluated at 15- and 18-percent rates of return, respectively) — base case and no percentage depletion . . 10 

8. Potential annual copper production from producing and nonproducing properties in selected 

years — base case and no percentage depletion 11 



TABLES 

1. Commodity prices used in the economic analyses 4 

2. Potential total copper production from currently producing properties at various prices and 

rates of return — base case 5 

3. Potential total copper production from nonproducing properties at various prices and 

rates of return — base case 5 

4. Potential total copper production from producing and nonproducing properties at various prices 

(evaluated at 15- and 18-percent rates of return, respectively) — base case 6 

5. Total depletion allowance and Federal income tax expense — base case and cost depletion only 8 

6. Economic effects of removing the percentage depletion allowance upon producing and nonproducing 

properties within various base case price ranges 8 

7. Potential total copper production from currently producing properties at various prices and 

rates of return — no percentage depletion 9 

8. Potential total copper production from nonproducing properties at various prices and 

rates of return — no percentage depletion 10 

9. Potential total copper production from producing and nonproducing properties at various prices 

(evaluated at 15- and 18-percent rates of return, respectively) — no percentage depletion 10 

10. Economic effects of removing the depletion limit and minimum Federal tax upon producing and 

nonproducing properties within various base case price ranges 12 

11. Economic effects of changing the statutory rate of depletion allowance applicable to copper upon 

producing and nonproducing properties within various base case price ranges 13 



THE DEPLETION ALLOWANCE AND DOMESTIC MINERALS AVAILABILITY 

A Case Study in Copper 

By Paul R. Thomas, 1 Robert L. Davidoff, 2 and Melinda M. Quinn 1 

ABSTRACT 

The Bureau of Mines evaluated the impact of the depletion allowance upon the 
economic availability of copper from domestic deposits. The potential long-run 
percentage depletion deduction, cumulated over the life of the properties, was 
estimated at approximately $2.5 billion for producing properties and up to $11.7 
billion for nonproducers. The income transfer, in the form of higher Federal income 
tax payments if the allowance were repealed, was estimated at $1.5 billion for pro- 
ducing properties and up to $8 billion for nonproducers. The percentage depletion 
allowance, through its role in determining Federal income tax liability, was found 
to be very significant in affecting profitability. Repeal of the allowance could result 
in major domestic copper availability reductions at all price levels, now and in the 
future, as a result of reduced profit margins for current producers, and postpone- 
ment of development decisions for nonproducers. It was demonstrated that a 
50-percent reduction in the percentage depletion rate applicable to copper would 
also result in a significant decrease in profitability for nonproducing properties. 
For producing properties, the percentage depletion rate on copper was shown to 
be less significant than the income limitation that is placed upon the total amount 
of the depletion deduction. Repeal of the minimum Federal tax provision was 
shown to be significant in enhancing profitability for both producing and non- 
producing deposits. The report concludes that the percentage depletion allowance 
operates as an important method of capital recovery and production incentive. 

1 Economist. 

2 Minerals economist. 

All authors are with the Minerals Availability Field Office, Bureau of Mines, Denver, Colo. 



INTRODUCTION 



The U.S. mining industry has become the subject of 
intense scrutiny in light of recent developments re- 
garding shortages of raw materials. The interrelated 
issues of import dependence and domestic availability 
are central to the formation of a national minerals 
policy. Both areas of minerals availability, domestic and 
international, are affected by the system of taxation 
that affects the economics of mining firms in the United 
States and abroad. The general tax system is part of the 
price-determining environment in which mining firms 
operate. The prices of mineral products are affected 
both by the general tax system and the industry-specific 
tax preferences that apply to mineral production. 

The affect of mineral tax preferences (positive or 
negative) on altering either the structure of import 
dependence or the domestic availability of strategic 
minerals, is itself intrinsically bound to the level of prof- 
itability of the domestic mining industry. It is through 
their effect upon profitability that mineral tax prefer- 
ences work to alter both the structure of import 
dependence and the economic availability of domestic 
resources. 

The tax structure applying to the mining industry con- 
tains a unique provision which is a factor of importance 
to economic viability. This is the depletion allowance. 3 
This allowance has been a controversial subject since 
its introduction in 1926, and while some studies have 
recommended its repeal (10, p. 166) 4 and others have 
recommended its continuation (9, p. 4B-12), all have 
done so without agreement as to the current effect of 
the depletion allowance or the possible effects of its 
repeal. The arguments for and against the allowance 
have been well discussed (2, 4-5, 13, 15) but quantifica- 
tion of the size of the total depletion deduction and its 
effect upon profitability and minerals availability has 
been inadequate. It is the purpose of this study to quan- 
titatively address two major issues that have been 
raised concerning the impact and effectiveness of the 
allowance and its provisions. First, does the depletion 
allowance represent a production incentive, and if so, 
does the tax expenditure cost to the Federal Govern- 
ment outweigh the production incentive? Second, what 
is the potential reduction in domestic mineral availabili- 
ty that could result from a reduction or repeal of the 
depletion allowance? 



The first question is addressed by quantifying the 
minimum potential long-run size of the total depletion 
deduction and the corresponding minimum potential 
long-run size of the Federal income tax expense that 
would occur with and without the percentage depletion 
allowance. The effect upon profitability (production in- 
centive) is then measured by comparing the resulting 
difference in average total cost 5 of mineral production 
for each of the deposits analyzed. To address the sec- 
ond question, this cost information is then aggregated 
for all deposits and correlated with an analysis of total 
and annual mineral availability to ascertain the poten- 
tial reduction in availability as a result of repealing or 
reducing the depletion allowance. 

When analyzing the impact of the depletion allow- 
ance there are three distinct effects that require isola- 
tion. First, the effect upon each individual deposit from 
altering or repealing certain rates and provisions of the 
allowance must be ascertained. Second, the differential 
effect upon currently producing and nonproducing prop- 
erties needs to be addressed. Finally, total resource 
availability must be analyzed to fully ascertain the ag- 
gregate, long-term effects of this allowance. 

In order to address the issue of mineral supply avail- 
ability in specific terms, the long-run domestic supply 
availability of primary copper from 33 producing and 33 
nonproducing deposits is analyzed under different 
depletion allowance scenarios. The point of view 
adopted in this analysis is both deposit specific and 
generalized over all deposits. Each deposit is evaluated 
on its own merits to determine the price at which the 
prime commodity must sell to cover full costs of pro- 
duction and obtain a stipulated rate of return. In addi- 
tion, the deposits are grouped according to price ranges 
established by the "base case" price determination 
analysis. 6 This allows for aggregation and analysis of 
deposits of similar economic conditions, and further, 
allows for calculations of weighted average total cost 
of production and total resource availability estimates. 

The analyses conducted for this study were per- 
formed using the Minerals Availability System (MAS) 
supply analysis model (SAM). A discussion of the SAM 
as it applies to mineral tax analysis follows. 7 



MINERAL TAX ANALYSIS EMPLOYING THE MAS SUPPLY ANALYSIS MODEL (SAM) 



MAS is a continuously evolving methodology for the 
analysis of long-run mineral resource availability. An in- 
tegral part of this system is the SAM. This computer 
system has evolved into an effective mathematical tool 
for analyzing the effects of varying tax policies upon the 
economic availability of domestic and international 
mineral resources. 

The SAM system is a comprehensive financial analy- 



' Unless otherwise stated, the term depletion allowance refers to per- 
centage depletion. 

4 Italic numbers in parentheses refer to items in the list of references at 
the end of tnis report. 



sis simulator that enables the Bureau of Mines to per- 
form discounted cash flow rate of return (DCFROR) 
analyses to determine the price of the primary com- 
modity required to obtain a specified rate of return. The 
DCFROR is defined as that rate which makes the pres- 



s In this study the average total cost of primary mineral production 
(which includes a stipulated rate of return on total investment) is 
assumed to equal the market price at which primary commodity is 
sold. Thus, price equals average total cost. 

8 As defined in "The Depletion Allowance: Rationale and Operation" 
section. 

7 For a complete discussion of the SAM see reference 3. 



ent value of all future revenues equal to the present 
value of all future costs. All capital investments in- 
curred 15 years prior to the initial year of analysis are 
treated as sunk costs. Capital investments incurred 
less than 15 years prior to the initial year of analysis 
have the undepreciated balances carried forward to that 
year, with all subsequent investments reported in con- 
stant dollar terms. This generally results in the deter- 
mination of a lower primary commodity price for cur- 
rently producing properties since the total cost basis of 
producing properties is generally less than non- 
producers. 

For this study, a minimum rate of return of 15 percent 
was specified when determining a nonproducing prop- 
erty's incentive price for the primary commodity copper. 
That is the price at which a firm would be willing to pro- 
duce the commodity, over the long run, and enable it to 
cover full costs, where full costs include a 15-percent 
return on the total investment. This rate was considered 
the minimum sufficient to attract new capital to the in- 
dustry. In addition, price determination analyses were 
performed employing an 18-percent rate of return in 
order to establish a range of expected prices corre- 
sponding to this range of minimum expected rates of 
return. 

For producing properties, price determination anal- 
yses were performed at 0- and 15-percent rates of 
return. A break-even rate of return (0-percent DCFROR) 
was specified for producers in order to determine the 
minimum size of the total depletion deduction potential- 
ly available to the copper industry over the long run. 
This rate of return is sufficient for covering the total 
cost of production but provides no positive return on the 
investment. In addition, a rate of return of 15 percent 
was specified in order to more realistically determine 
the expected size of the total depletion deduction and 
minimum sales price of copper necessary to maintain 
adequate profitability over the long run. 

The SAM system contains a separate tax records file 
for each State and foreign country. These records con- 
tain all the relevant tax parameters under which the 
mining firm would operate. These tax parameters are 
applied to each mineral deposit under evaluation with 



the implicit assumption that each deposit represents a 
separate corporate entity. In addition, the tax calcula- 
tion routine allows for the varying of these parameters 
and calculation options. By varying the depletion allow- 
ance rates and options one can ascertain what effect, 
for instance, removing the allowance will have upon the 
determination of the necessary primary commodity 
price. 

The SAM produces detailed cash flow analyses for 
each preproduction and production year of the deposit 
beginning with the initial year of analysis. In addition, 
all properties within an industry that have been identi- 
fied for inclusion in the study can be simultaneously 
analyzed and aggregated onto an availability curve. 
This curve is a tonnage-price relationship that shows 
the total recoverable product available at specified 
long-run prices. It is an aggregation of average total 
cost of production from each deposit which would even- 
tuate over the entire producing life of the deposits. 

Certain assumptions are inherent in this curve. First, 
all deposits produce at full operating capacity through- 
out the productive life of the deposit. Second, each 
operation is able to sell all of its output at the deter- 
mined price 8 and obtain at least the minimum specified 
rate of return. Third, all development of each nonpro- 
ducing deposit began in 1981. 

Annual availability curves are also constructed to ac- 
count for the time lags involved in achieving the total 
production potential illustrated by the total availability 
curve. These are simply the total curve disaggregated 
on a yearly basis. 

The analyses which follow are sensitivity analyses 
that vary the depletion allowance rates and provisions, 
and isolate price, availability, and tax cost changes that 
result from varying the parameters of this allowance. 
The following section deals with the general provisions 
and rationale of the allowance. Subsequent sections 
present the results from (a) repealing the percentage 
depletion allowance; (b) removing the standard U.S. in- 
come limitation; (c) removing the minimum Federal tax 
provision that applies to a portion of the allowance as a 
tax preference item; and (d) altering the percentage 
depletion allowance rate applicable to copper. 



THE DEPLETION ALLOWANCE: RATIONALE AND OPERATION 



Mineral deposits are capital goods produced via in- 
vestment in exploration, acquisition, and development, 
which yield a flow of productive services over the pro- 
ducing life of the deposit. Relative deposit quality and 
quantity determine the magnitude and duration of the 
flow of productive services. As is the case with other 
forms of capital assets, mineral deposit assets depreci- 
ate in value as their flow of productive services dimin- 
ishes. Thus, the concept of capital recovery applies to 
depletable mineral deposits in the same way as depreci- 
ating capital goods in general. This is the primary ra- 
tionale for the existence of the depletion allowance (2). 

In addition, it is argued (2) that investment in the re- 
placement of mineral deposits carries with it a higher 
degree of risk than investment in general capital goods. 
This relatively higher risk requires an additional risk 
premium to attract the required financial capital. The 



depletion allowance, by reducing taxable income, in- 
creases profitability. This is purported to increase the 
attractability of risk capital to the industry, inducing fur- 
ther expansion of total capacity and increasing domes- 
tic supply. Indeed, the perceived existence of a relative- 
ly high degree of risk is a historic argument in favor of 
the depletion allowance. This factor, coupled with the 
depreciating value of exploited mineral property assets, 
serves as the overall reasoning behind the existence of 
this tax provision. 

Because the depletion allowance represents a spe- 
cial deduction for mineral producers to reduce the 



Since price equals average total cost (which includes an assumed 
normal rate of return) the price-cost differential equals zero and there 
are no abnormal profits in an economic sense. 



amount of income subject to taxation, it is, in effect, 
both a production subsidy and a method of capital re- 
covery. Any production subsidy, by its nature and de- 
sign, is non-neutral. It affects the profitability of the 
target industry (in this case copper), the level and com- 
position of output, and by interaction, the allocation of 
capital resources throughout the economy. Thus, the 
depletion allowance affects both investment and pro- 
duction. 

For this study, the basic assumptions are that invest- 
ment in exploration, acquisition, and development re- 
sponds systematically to signals of profit and loss 9 and 
that allowances for capital recovery (depletion) are 
directed towards reinvestment in the minerals industry. 

Currently, the percentage depletion allowance for 
copper is 15 percent of gross income, 10 with a 50 per- 
cent of before-tax income (BTIN) limitation. 11 Com- 



panies are required to deduct the lesser of the two 
sums. The difference between allowable percentage de- 
pletion and the allowance using cost depletion 12 is con- 
sidered to be a tax preference item. The total of all tax 
preference items is subject to a 15-percent minimum 
Federal tax, which is assessed upon this total, reduced 
by $10,000 or the current year's tax liability, whichever 
is greater. The minimum Federal tax is not an industry- 
specific tax item, it applies to all tax preference items. 
For the purpose of isolating the interaction of the mini- 
mum Federal tax with allowable depletion, the analyses 
incorporated only the excess of percentage over cost 
depletion as a tax preference item subject to this mini- 
mum tax. The industry-specific tax items, including 
State mineral severance taxes, in conjunction with gen- 
eral Federal, State and local tax laws, constitutes the 
"base case" of-the analysis. 



DOMESTIC COPPER AVAILABILITY BASE CASE ANALYSIS 



The long-run availability of domestic copper re- 
sources was evaluated employing the MAS data base (1, 
17) and data analysis systems (3). The current U.S. cop- 
per reserve base was defined as containing 40.1 million 
metric tons of recoverable copper from 33 producing 
properties and 21.6 million metric tons in 33 currently 
nonproducing deposits. 13 All deposits were evaluated in 
terms of constant March 1981 costs and prices. Byprod- 
uct and coproduct prices for March 1981 are given in 
table 1. All costs and prices were assumed to escalate 
at the same rate. The producing deposits were evalu- 
ated using the price determination method employing 
break-even (0-percent) and 15-percent rates of return. 
The nonproducing properties were evaluated similarly 
employing rates of return of 15 and 18 percent. 

TABLE 1. — Commodity prices used in the economic 

analyses 

Price, 
Commodity and unit March 1981 dollars 

Cobalt pound . . 25.00 

Gold troy ounce . . 498.76 

Iron metric ton . . 80.50 

Ferromolybdenum pound . . 10.85 

Molybdenum do . . 9.35 

Nickel do . . 3.45 

Platinum troy ounce . . 475.00 

Selenium pound . . 10.50 

Silver troy ounce . . 12.34 

Sulfur metric ton . . 130.00 

Tungsten pound . . 14.70 

Zinc do . . .41 

Sources: Engineering and Mining Journal and Bureau of Mines Minerals 
and Materials/Monthly Survey. 



For the 33 producing properties analyzed (see fig. 1 
and table 2), 1 1 can operate and break even in a long-run 
price interval of $0.93 per pound or less of recoverable 
copper. An additional 11 properties can operate and 
break even in a price interval of $0.94 to $1 .07 per pound. 
The remaining 11 properties operate in a price interval 
ranging from $1.07 to $1.64 which is suggestive of at 
least short-term, intermittent loss. This is clearly not in- 
dicative of industry profitability strength since a break- 
even rate of return, at which these prices were calcu- 
lated, will not sustain the industry over the long run, and 
obtaining a higher rate of return would require market 
prices, for many deposits, higher than recent averages. 
For example, in a long-run price interval of $0.93 or less 
only eight currently producing properties can operate 
and obtain a 15 percent rate of return on the total invest- 
ment. In a long-run price interval of $1 .06 or less an addi- 
tional 11 properties can operate and obtain the mini- 
mum stipulated rate of return. The remaining 14 proper- 
ties operate in a price interval that ranges from $1.07 to 
$1.84. With the price of copper wirebar averaging $0.93 
per pound in 1979, $1.02 in 1980, and $0.87 through 
March of 1981 (76), this analysis suggests that some in- 
dividual deposits are not obtaining the 15-percent rate 
of return, while some are operating at a loss in real 
terms. 

For the 33 nonproducing deposits analyzed (see fig. 2 
and table 3), it was found that 11 could operate in a 
long-run price interval of $1.28 or less and obtain the 
minimum desired 15-percent rate of return on total in- 
vestment. An additional 11 could operate at prices rang- 
ing from $1.29 to $1.58 and the remaining 11 would re- 



• Orris Herfindahl (2, p. 112) concluded that "the record of copper price 
and output on the whole is consistent with the view that investment in 
copper is systematic and that it responds reasonably well to signals 
of profit and loss." 

•Gross income equals commodity revenues, less smelter and refinery 
operation cost and royalty payments. 

" Before-tax income equals gross income less total operating costs, 
total transportation costs, all amortization and depreciation, previous 
year State tax, previous year severance tax, present year property tax, 
royalty payments, and loan interest payments. 



12 Cost depletion is defined mathematically as 

(mineral units removed and sold during year) 
(a jus e i) (mineral units recoverable at beginning of year) 

where adjusted basis egjals cost basis plus or minus adjustments 
less cumulative depletion (14, p. 211). This is discussed in greater 
detail in the "Quantifying the Total Depletion Deduction and Federal 
Income Tax Expense" section. 
"The reserve base is defined according to the guidelines as detailed in 
reference 18. For this study, the reserve base is restricted in definition 
to the 66 deposits analyzed. 





190 

■ 1*0 

5 i to 

1 160 
5 I 50 

en 

- .«0 

5 '*> 

2 I 20 
o" I 10 

3 1.00 
2 90 
5 *> 



KEY 

15- percent rate of return 

0- percent rate of return 



JT 



4 8 12 16" 20 24 28 32 36" 40 

TOTAL RECOVERABLE COPPER, million metric tons 

FIGURE 1. — Potential total copper production from 
currently producing properties at various 
prices and rates of return— base case. 



TABLE 2. — Potential total copper production from 
currently producing properties at 
various prices and rates of 
return— base case 



Copper price, 
U.S. dollars 
per pound 1 


Number 

of 
properties 


Potential 
total Cumulative 
production, number of 
million properties 
metric tons 


Cumulative 

total 
production, 

million 
metric tons 


BREAK-EVEN RATE OF RETURN 


to 0.94 

0.94 to 1.07 .. 
1.07 to 1.84 .. 


11 
11 

11 


16.949 11 
12.348 22 
10.835 33 


16.949 
29.297 
40.132 


15-PERCENT RATE OF RETURN 


to 0.94 

0.94 to 1.07 .. 
1.07 to 1.84 .. 


8 
11 
14 


14.699 8 
10.289 19 
15.144 33 


14.699 
24.988 
40.132 



Price equals average total cost, Includes byproduct credits. 




2.60 
• 2 40 
! 2.20 
i 2J0O 

> l 80 
f 

j, 1*0 

r 

\ 1.40 

: '- 20 

! '00 

I 

> .80 




I I 1 1 1 

KEY 

18 - percent rate of return 

15- percent rate at return 







4 6 8 10 12 14 16 16 20 

TOTAL RECOVERABLE COPPER, million metric ton* 



FIGURE 2. — Potential total copper production from 
nonproducing properties at various 
prices and rates of return— base case. 



TABLE 3. — Potential total copper production from 
nonproducing properties at various 
prices and rates of return- 
base case 







Potential 




Cumulative 


Copper price 


Number 


total 


Cumulative 


total 


U.S. dollars 


of 


production, 


number of 


production, 


per pound 1 


properties 


million 
metric tons 


properties 


million 
metric tons 



15-PERCENT RATE OF RETURN 


to 1.29 .... 
1.29 to 1.58 .. 
1.58 to 2.17 .. 


11 5.689 11 
11 6.459 22 
11 9.518 33 


5.689 
12.148 
21.666 


18-PERCENT RATE OF RETURN 


to 1.45 .... 
1.45 to 2.00 .. 
2.00 to 2.56 . . 


11 4.152 11 
11 9.309 22 
11 8.205 33 


4.152 
13.461 
21.666 



Price equals average total cost, includes byproduct credits. 



quire long-run market prices of at least $1.58 per pound 
to ensure operation at the minimum level of profitabili- 
ty. To achieve an 18-percent rate of return, a long-run 
price per pound of $1.99 would be required to enable 
two-thirds of the deposits to operate, and prices as high 
as $2.55 per pound would be required to ensure produc- 
tion from all 33 deposits. It is the nonproducing proper- 
ties that will most likely provide additional domestic 
availability for the duration of this century, and as such, 
it is the economics of these deposits which is most cen- 
tral to a discussion of long-run copper resource avail- 
ability. Any tax legislation that alters the economics of 
these deposits in a negative way serves to lengthen the 
time frame for their eventual development. 

Figure 3 and table 4 presents the results of the "base 
case" total availability analysis for all producing and 
nonproducing properties. The producers were evaluated 
at a rate of return of 15 percent, nonproducers were 
evaluated at an 18-percent rate of return. These rates 
were assumed sufficient to maintain adequate profita- 
bility over the long run and provide for a risk premium on 



nonproducers high enough to induce investment and 
development. This analysis indicates that at a long-run 
copper price per pound of $1.00, approximately 20.6 mil- 
lion metric tons of copper are potentially recoverable. 
At this price, 17 properties could produce and earn the 
stipulated rate of return on the total investment. Of 
these 17 properties, 15 are current producers. The re- 
maining two potential producers account for 0.357 mil- 
lion metric tons, or 1.7 percent of the total copper 
resource availability estimate. 14 

At a long-run copper price per pound of $1.25, approx- 
imately 37.1 million metric tons of copper are potential- 
ly recoverable. At this price, 35 properties could pro- 
duce and earn the stipulated rate of return on invested 
capital. Of these 35 properties, 28 are current pro- 
ducers. The remaining seven potential producers ac- 
count for 2.170 million metric tons, or 5.8 percent of the 
total copper resource availability estimate at this price. 



' For a detailed discussion of the availability of domestic copper, see 
reference 12. 



3 UU 


1 1 1 


1 1 1 






■ 






■ 






- 


2 50 


- 


- 


m 












o 












o 






■o 




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U 






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10 20 30 40 50 60 70 

TOTAL RECOVERABLE COPPER, million metric tons 



FIGURE 3. — Potential total copper production from 
producing and nonproducing properties 
at various prices (evaluated at 15- and 
18-percent rates ot return, respectively) 
—base case. 



At a long-run price of $1.50 per pound, the total avail- 
ability estimate increases to approximately 44.0 million 
metric tons of recoverable copper. Of the 43 properties 
that could produce at this price, 31 are currently pro- 
ducing. The remaining 12 potential producers now ac- 
count for 6.127_raJllion metric tons, or 13.9 percent of 
the total availability estimate. 

At a long-run price per pound of $2.55, an additional 2 
producing and 21 nonproducing properties, with esti- 
mated recoverable copper reserves of 17.753 million 
metric tons, could produce. This increases the total 
copper availability estimate to approximately 61.8 mil- 
lion metric tons, with the 33 currently nonproducing 
deposits accounting for a total of 21.666 million metric 
tons, or 35.0 percent of the overall total availabiiity 
estimate. 



TABLE 4. — Potential total copper production 

producing and nonproducing proper- 
ties at various prices (evaluated 
at 15- and 18-percent rates 
of return, respectively)— 
base case 

Number of properties Potential Cumulative 

Copper price total Cumulative total 

U.S. dollars Producing Norv production, number of production, 
per pound 1 producing million properties million 

metric tons metric tons 



to 1.01 .... 


15 


2 


20.654 


17 


20.654 


1.01 to 1.26.. 


13 


5 


16.481 


35 


37.135 


1.26 to 1.51 .. 


3 


5 


6.910 


43 


44.045 


1.51 to 2.01 .. 


2 


14 


11.559 


59 


55.084 


2.01 to 2.56 . . 


<0 


7 


6.194 


66 


61.798 



1 Price equals average total cost, includes byproduct credits. 



Annual resource availability curves for selected years 
are illustrated in figure 4. The curves are cumulative 
over each year at a given price. Thus, in 1981, at a cop- 
per price per pound of $1.55, approximately 1.620 mil- 
lion metric tons of copper are potentially available from 
32 currently producing properties. By 1987, total annual 
availability at this price increases to 1.8 million metric 
tons as 14 nonproducing properties come on line to 
replace eight current producers whose recoverable re- 
serves, as defined previously, have been exhausted by 
that year. Holding production levels constant for all 
properties producing at this price, in each successive 
year, would cause production to decrease to aDDroxi- 
mately 1.7 million metric tons by 1990 and 1.140 million 
metric tons by the year 2000. This is the result one 
would expect from a static analysis employing a fixed 
reserve base estimated under current price-cost rela- 
tionships and technology conditions. The analysis in- 
tends not to suggest exhaustion in the absolute sense, 
only exhaustion of this fixed reserve base. As both the 
price-cost differential and technology change, and as 
new deposits are discovered, the reserve base as de- 
fined, changes as well. 

Taking these availability results as the base case of 
this analysis, the effects upon potential availability 
from replacing the current depletion allowance option 
(the greater of cost or percentage depletion) with an al- 
lowance for cost depletion only can be investigated. 



REPEALING THE PERCENTAGE DEPLETION ALLOWANCE 



QUANTIFYING THE TOTAL DEPLETION DEDUCTION 
AND FEDERAL INCOME TAX EXPENSE 

The major difference between cost and percentage 
depletion lies in the definition and application of the 
two capital recovery methods. "Cost depletion is based 
upon the cosf of a mineral property, the number of units 
of mineral or contained metal sold during the year, and 
the number of units of mineral or contained metal re- 
maining in the deposit at the end of tne year" (0, p. 3.46). 



The ultimate size of the total cost depletion deduction 
is based upon the determination of the "cost basis." 
This cost basis establishes the maximum deduction 
under cost depletion for which the property is eligible 
over its producing life. The original cost basis. 18 once 
determined, is reduced In each successive year by sub- 

16 The cost basis herein employed was defined as the total of explora- 
tion and acquisition expenditures incurred during all preproduction 
and production years. 



o 

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o. 

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LU 
0. 

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1 1 1 i i 




- 1981 


2.00 


- 






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- 


1.50 


- 






; ^^J ; 


1.00 


: r— ^ : 


.50 


^-T 







i i i i — i — 




2.50 



2.00 - 



1.50 - 




1.00 - 



12 16 20 24 4 8 12 

ANNUAL RECOVERABLE COPPER, million metric tons 



24 



FIGURE 4. — Potential annual copper production from producing and nonproducing properties in selected years- 
base case. 



tracting from it the depletion taken, whether it be cost 
or percentage. This "adjusted" cost basis thus de- 
creases, eventually reaching zero. Table 5 illustrates 
the difference between cost and percentage depletion 
and the corresponding difference in Federal income tax 
expense. 18 

"Federal income tax expense is defined as 46 percent of taxable in- 
come. 



As the data clearly indicate, the base case allows for 
a substantially larger total depletion deduction, ulti- 
mately in excess of the total allowable cost depletion 
deduction for both producing and nonproducing proper- 
ties. As a result, the total Federal income tax expense 
increases with repeal of percentage depletion. The end 
result is a potential minimum income transfer from cop- 
per producers to the Federal government of approxi- 
mately $304 million and a potential transfer, given a 



TABLE 5. — Total depletion allowance and Federal 
income tax expense— base case 
and cost depletion only 

(Million 1981 dollars) 



Property 


Total depletion 


Total Federal income 


status 


deduction' 




tax expense' 




Base 


Cost 


Base 


Cost Difference 5 




case 3 


depletion 
only 


case 


depletion 
only 


Producing: 










0-pct DCFROR 


1,047 


106 


399 


703 304 


15-pctDCFROR 


2,525 


106 


1,100 


2,593 1,493 


Nonproducing: 










15-pctDCFROR 


9,749 


259 


5,007 


11,353 6,346 


18-pct DCFROR 


11,738 


259 


7,134 


15,212 8,078 



' Summed over all production years for all properties in undiscounted 
dollars. 

■ As defined in "The Depletion Allowance: Rationale and Operation" 
section. 

' Direct correlation between these numbers should not be construed 
due to the interactive complexities of the tax structure (i.e., tax loss 
carry, investment tax credits, etc.) 



15-percent rate of return, of approximately $1.5 billion 
from currently producing deposits. 

Since these analyses determine commodity price and 
revenues they also determine the ultimate size of the 
total depletion deduction for all properties. This further 
underscores the greater value to the minerals industry 
of percentage depletion. Cost depletion deductions are 
not proportional to total revenue, percentage depletion 
deductions are. Therefore, the larger the revenues, the 
larger the potential percentage depletion deductions 
and conversely, the larger the potential minimum in- 
come transfer from its repeal. 

In the case of the producing properties, the analyses 
determined for each deposit, that price necessary to 
generate sufficient revenues to cover all costs and pro- 
vide a 0-percent rate of return, and the price necessary 
to generate revenues sufficient to cover ail costs and 
provide a 15-percent rate of return. As a result, the total 
depletion deduction was limited to a minimum of ap- 
proximately $1,047 billion and a expected value of 
$2,525 billion. In these analyses, the difference between 
price and average total cost is zero. Each deposit is 
assumed to sell all output at a price that is equal to its 
average total cost of production. Therefore, the pro- 
ducing deposits in total would receive no less than this 
minimum $1,047 billion depletion deduction estimate 
and the corresponding $304 million tax savings it 
represents. In all probability, however, the minimum 
total depletion deduction can be expected to approach 
$2.5 billion and the Federal tax savings to approach $1 .5 
billion since these minimum estimates correspond to 
the analysis of a 15-percent return over the long run. 

In the case of the nonproducing deposits, the total 
percentage depletion deduction is substantially larger 
because most deposits analyzed would require per 
pound prices of $1.50 to $2.50 (hence larger total 
revenues) in order to cover total costs and obtain the 
desired rate of return. Thus, the question of retention or 
repeal of the allowance assumes even greater signifi- 
cance. 

Assuming that 15 percent represents a minimum ac- 
ceptable rate of return to initiate exploitation, then a 
minimum total percentage depletion deduction of ap- 



proximately $9.7 billion (table 5) is determined with each 
deposit selling all output at a price equal to average 
total cost. At 18 percent, the total depletion deduction 
increases to $11.7 billion. Thus, with repeal of the per- 
centage depletion deduction, the total Federal income 
tax expense would increase by approximately $6.3 to 
$8.0 billion over the total producing lives of all deposits, 
with $6.3 billion representing a minimum. 



MEASURING THE WEIGHTED AVERAGE 
TOTAL COST OF PRODUCTION 

The end result of repealing the percentage depletion 
allowance would be a reduction in profitability. This is 
demonstrated here by the determination of higher nec- 
essary prices to allow for production at the stipulated 
level of profitability. 

Table 6 illustrates this economic effect, for all pro- 
ducing and nonproducing deposits analyzed, from re- 
pealing the percentage depletion allowance. The prop- 
erties are separated into three price (average total cost) 
ranges according to their base case price determina- 
tions. The weighted average total cost per pound of re- 
coverable copper was then calculated for the properties 
in each price range with and without percentage deple- 
tion. The average total cost was presented on a 
weighted basis in order to obviate a comparison be- 
tween individual deposits on the basis of size, quality, 
or composition, and instead adopt a more general and 
unbiased measure. 

With repeal of the percentage depletion allowance, 
the projected increase in weighted average total cost 
per pound of recoverable copper for nonproducing prop- 
erties is much greater than for current producers. This 
is due primarily to the loss of an additional $7 to $9 bil- 
lion in potential depletion deductions, proportionately 

TABLE 6. — Economic effects of removing the percent- 
age depletion allowance upon producing 
and nonproducing properties within 
various base case price ranges 



Property 


Number 


Base case 


No percentage 


Percentage 


status 


of 


weighted 


depletion 


change from 




properties 


average total 


weighted 


base case 






cost 


average total 


pet 






per pound' 


cost per 
pound' 




Producing, 










15-pct ROR: 










to 0.51 .... 


3 


0.401 


0.412 


2.7 


0.51 to 1.26 . 


25 


1.031 


1.060 


2.8 


1.26 to 2.01 . 


5 


1.451 


1.485 


2.3 


Nonproducing, 










15-pct ROR: 










to 0.51 .... 


1 


.410 


.530 


29.2 


0.51 to 1.26 . 


9 


1.100 


1.231 


12.0 


1.26 to 2.01 . 


21 


1.654 


1.822 


10.2 


2.01 to 2.51 . 


2 


2.143 


2.494 


16.4 


Nonproducing, 










18-pct ROR: 










to 0.52 .... 


1 


.510 


.670 


31.4 


0.52 to 1.26 . 


6 


1.130 


1.312 


16.1 


1.26 to 2.01 . 


19 


1.596 


1.771 


11.0 


201 to 2.56 . . 


7 


2.211 


2.501 


13.1 



' Weighted average total cost represents the long-run market price per 
pound of copper necessary to cover full costs from all deposits in each 
price range. 



higher Federal income tax expenses, higher total 
capital costs, and the resultant determination of total 
revenues large enough to cover these total costs. The 
producing properties, for the most part, have recouped 
their initial (historical cost) investments, thus they have 
lower total costs relative to the nonproducing deposits 
which require huge capital investments in order to initi- 
ate exploitation. Therefore, for producing properties, 
both the absolute size of the depletion deduction and 
the economic effects of its repeal are to be interpreted 
as minimums, whereas the size of the total depletion 
deduction and the economic effects of its repeal upon 
nonproducing properties represents the expected 
future results since these properties represent current 
resource replacement costs. 

For the nonproducing deposits, the increase in cost 
from removing the percentage depletion allowance, as 
noted in table 6, is quite large. The importance of this in- 
crease to minerals availability lies in the fact that feasi- 
bility studies performed with the assumption of no per- 
centage depletion allowance will render these proper- 
ties less economic. This could result in the postpone- 
ment of development decisions and the resulting post- 
ponement in the economic availability of copper and its 
associated by-products and coproducts to the domestic 
economy from these deposits. For the nine nonpro- 
ducing deposits in the 15-percent rate of return base 
case price range of $0.51 to $1.26, the weighted average 
total cost of production per pound of recoverable cop- 
per was $1.10. Repealing the allowance would result in 
an average increase in the necessary price of recover- 
able copper of $0,131 per pound (12.0 percent) to $1.23 
per pound. For the 21 deposits in the $1 .26 to $2.01 price 
range, the effect is similar. Repeal of the percentage 
depletion allowance would result in an average increase 
of $0,168 per pound of recoverable copper (10.2 percent) 
to $1.82 per pound. 

At an 18-percent level of profitability, the economic 
effect of repeal upon nonproducers is even greater. 
Only six properties could operate at this profitability 
level, in a price range of $0.51 to $1.26, with the per- 
centage depletion allowance in effect. Repeal of the al- 



lowance raises their weighted average total cost from 
$1.13 to $1.31 per pound or 16.1 percent. Further ex- 
amination of the data in table 6 demonstrates quite 
clearly that regardless of the arguments raised concern- 
ing the efficiency and rationality of the percentage 
depletion allowance, its importance to profitability and 
economic viability is certain. 



COPPER PRICE AND AVAILABILITY 

Figures 5 and 6 and tables 7 and 8 show the price 
ranges and availability estimates corresponding to indi- 
vidual producing and nonproducing properties, respec- 
tively, from repeal of the percentage depletion allow- 
ance. As in the base case analyses, producers were 
evaluated at break-even (0-percent) and 15-percent rates 
of return, nonproducing deposits at 15- and 18-percent 
rates. 

The producing properties at the 15-percent rate of 
return level require an overall necessary price increase 
of $0.03 per pound, to $1.86, in order for all 33 individual 
deposits to produce the total copper availability esti- 
mate of 40.132 million metric tons. These individual 
deposit results (fig. 5) are comparable to the aggregated 
results presented in table 6. 

The price ranges for nonproducing properties deter- 
mined with no percentage depletion allowance widen 
considerably. At the minimum 15-percent level, an over- 
all increase of $0.40 per pound to $2.56, relative to the 
base case price of $2.16, is required to allow all proper- 
ties to produce and earn the minimum rate of return. At 
the 18-percent level, an overall increase of $0.53 per 
pound to $3.08, relative to the base case price of $2.55, 
would be required to allow all properties to produce at 
this level. 

Figure 7 and table 9 illustrate the total potential re- 
duction in future supply availability, at each price level, 
for all 66 properties from repeal of this allowance. In 
order to estimate what the expected reduction would 
be, the total availability curves presented (base case 
and no percentage depletion) are those determined at 
the minimum and necessary rates of return (15- and 
18-percent) for producing and nonproducing properties 



I 90 

«. ISO 

| 1.70 

•S 1.60 

5 1.50 
en 

~ 140 

" 1.30 

o 

2 I 20 

o" 1. 10 

=> 1.00 

O 

o- 90 

E 80 



— i 1 1 1 r 

KEY 

15-percent rote of return 

0- percent rate of return 




TOTAL RECOVERABLE COPPER, m 



28 12 M 

I lion metric tons 



FIGURE 5. — Potential total copper production from 

currently producing properties at various 
prices and rates of return— no percentage 
depletion. 



TABLE 7. — Potential total copper production from 

currently producing properties at 

various prices and rates of 

return— no percentage 

depletion 



Copper price, 
U.S. dollars 
per pound' 


Number 

of 

properties 


Potential 
total Cumulative 
production, number of 
million properties 
metric tons 


Cumulative 

total 
production, 

million 
metric tons 


BREAK-EVEN RATE OF RETURN 


to 0.94 .... 
0.94 to 1.07 . . 
1.07 to 1.65 .. 


11 
11 
11 


16.949 11 
12.348 22 
10.835 33 


16.949 
29.297 
40 132 


15-PERCENT RATE OF RETURN 


to 0.94 

0.94 to 1.07 .. 
1.07 to 1.87 .. 


7 
10 
16 


14.617 7 
10.151 17 
15.364 33 


14.617 
24.768 
40.132 



1 Price equals average total cost, includes byproduct credits. 



10 




— i 1 1 i r 

KEY 

18- percent rote at return 

15- percent rate ot return 



¥ 



Y 



2 4 6 8 10 12 14 16 18 20 22 

TOTAL RECOVERABLE COPPER, million metric tone 

FIGURE 6. — Potential total copper production from 

nonproducing properties at various prices 
and rates of return— no percentage 
depletion. 



3.VJ 


1 1 1 1"" 

KEY 


-1 1 


- 




Cost only 




. 




Base cose 


r 


- 


3.00 




r 


■ 


2.50 






- 


2 00 




r 1 r-* 

If 

if 


- 




; <c 


"A 


- 


1.50 


— - i r J ~' 




- 








- 


1.00 


fzt2&=* 




- 




1 




■ 




J 




_ 


50 






- 




1 1 1 1 


1 - 1 


. 



2 "o - 



10 20 30 40 50 60 70 

TOTAL RECOVERABLE COPPER, million metrictons 

FIGURE 7. — Potential total copper production from 
producing and nonproducing properties 
at various prices (evaluated at 15- and 
18-percent rates of return, respectively) 
—base case and no percentage depletion. 

respectively. At a long-run price per pound of $1.00, ap- 
proximately 19.5 million metric tons of copper are 
potentially available from 13 producing and 1 currently 
nonproducing deposits. This is a reduction compared to 
the base case of approximately 1.1 million metric tons 
as one nonproducing deposit and two current producers 
are removed from this price range. 



TABLE 8. — Potential total copper production from non- 
producing properties at various 
prices and rates of return- 
no percentage depletion 



Potential Cumulative 

Copper price, Number total Cumulative total 

U.S. dollars of production, number of production, 

per pound 1 properties million properties million 

metric tons metric tons 



15-PERCENT RATE OF RETURN 


to 1.46 

1.46 to 1.72 .. 
1.72 to 2.57 .. 


11 4.152 11 
11 10.149 22 
11 7.365 33 


4.152 
14.301 
21.666 


18-PERCENT RATE OF RETURN 


Oto 1.61 .... 
1.61 to 1.89 .. 
1.89 to 3.09 .. 


'11 4.152 11 
11 10.149 22 
11 7.365 33 


4.152 
14.301 
21.666 



1 Price equals average total cost, includes byproduct credits. 



TABLE 9. — Potential total copper production from 
producing and nonproducing proper- 
ties at various prices (evaluated 
at 15- and 18-percent rates 
of return, respectively)— 
no percentage depletion 



Number of properties Potential Cumulative 

Copper price, " total Cumulative total 

U.S. dollars Producing Non- production, number of production, 
per pound 1 producing million properties million 

metric tons metric tons 



Oto 1.01 ... 


13 


1 


19.575 


14 


19.575 


1.01 to 1.26 . 


13 


2 


13.435 


29 


32.732 


1.26 to 1.51 . 


5 


7 


8.622 


41 


41.354 


1.51 to 2.01 . 


2 


14 


13.182 


57 


54.536 


2.01 to 3.09 . 





9 


6.984 


66 


61.798 



1 Price equals average total cost, includes byproduct credits. 



At a long-run price per pound of $1.25, the potential 
future availability reduction widens to 4.403 million 
metric tons, or 11.8 percent of the base case availability 
at this price. Two currently producing and four nonpro- 
ducing deposits now require necessary prices greater 
than $1.25 relative to their base case results of figure 3. 

A long-run price per pound of $3.08 is now needed to 
allow all current and potential producers to operate and 
achieve the same total availability estimate of 61.798 
million metric tons that was potentially available at a 
base case price of $2.55 per pound with the percentage 
depletion allowance provision. The general effect from 
repeal is to reduce, at any given price, the domestic 
economic availability of this mineral. In addition, it is 
certain that as the prices necessary to initiate exploita- 
tion of nonproducing deposits increase, the time at 
which these deposits will be exploited are further post- 
poned. This is demonstrated by annual availability 
curves. 

The annual availability curves (fig. 8) contrast this dif- 
ference in total availability for selected years. For 1981, 



11 



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! I 


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- 1987 






- 


— 




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- 




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- 






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Base case 


I I 


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- 1990 


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- 


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1 

- 2000 


1 I 


I l 


- 




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12 16 20 24 4 8 12 

ANNUAL RECOVERABLE COPPER, million metric tons 



16 



20 



24 



FIGURE 8. — Potential annual copper production from producing and nonproducing properties in selected years- 
base case and no percentage depletion. 



12 



the analysis indicates that only a marginal effect would 
have been felt. In that year only producing properties 
provide availability. The properties that would be af- 
fected most are those in the high-cost range. By 1987, 
however, a definite reduction in availability is apparent. 
Those nonproducers that could operate would require 
significantly higher market prices to cover their average 
total cost of production if they were to obtain an 18-per- 
cent rate of return. At a price of $1.55 per pound, approx- 
imately 1.6 million metric tons of recoverable copper 
would be available in that year. This is an annual reduc- 
tion of approximately 200,000 metric tons. By 1990, as- 
suming a constant price-cost differential and reserve 
base, annual availability would decrease to 1.5 million 
metric tons from 1.7 million metric tons that was poten- 



tially available at this price with the percentage deple- 
tion allowance provision retained. By the year 2000, an- 
nual availability further declines to 1.00 million metric 
tons from 1.140 million metric tons in the base case. 

To place these availability estimates in perspective, 
in 1980, total domestic comsumption of copper was 
2.767 million metric tons. Total domestic mine produc- 
tion accounted for 1.172 million metric tons (42 percent), 
with secondary production and imports accounting for 
the remainder/The price per pound of copper ranged 
from a low of $0.89 to a high of $1.33. Therefore, a total 
availability reduction of 4.403 million metric tons of cop- 
per at a long-run price per pound of $1.25 represents 159 
percent of apparent 1980 consumption, and 375 percent 
of mine production in that year (16). 



THE INCOME LIMITATION AND THE MINIMUM FEDERAL TAX 



Under current tax law, the total allowable percentage 
depletion deduction is limited to 50 percent of before- 
tax income (as defined in footnote 11). In addition, the 
excess of percent over cost depletion is considered a 
tax preference item and is subject to a 15-percent mini- 
mum Federal tax (6, p. 3.41). 

These two provisions effectively limit the amount of 
benefit that may be derived from the percentage deple- 
tion deduction. The 50-percent limitation places a 
ceiling upon the total amount of taxable income that 
can be shielded from normal income tax payments. It is 
an industry-specific tax provision and can be raised, 
lowered, or removed to affect just this industry. The 
minimum Federal tax is not specific to the mining in- 
dustry and as such cannot be considered solely in the 
context of mineral taxation. 

The two provisions are interdependent. Raising or 
lowering the depletion limit, in turn, raises or lowers the 
amount of tax preference items, which causes minimum 
Federal tax payments to increase or decrease accord- 
ingly. Numerous analyses were performed to ascertain 
the trade off between higher depletion limits and higher 
minimum Federal tax payments. 

For producing properties, removing the limit entirely 
resulted in substantially larger minimum Federal tax 
payments, as well as increased tax payments to State 
and local governments, that more than offset the reduc- 
tion in corporate Federal income tax payments ob- 
tained from removing the limit. For nonproducing 
deposits, it was found that the economic effect from re- 
moving the income limitations, although resulting in 
iower weighted average total costs, was not large 
enough to significantly improve the economics of these 
deposits. Conversely, removing the minimum Federal 
tax that applies to the excess depletion deduction, re- 
sulted in a more economically significant decline in 
weighted average total cost. These results are 
presented in table 10. 

The significance of these results vary according to 
the time frame in which they are viewed. Although a 
decrease in the weighted average total cost for 25 pro- 
ducing deposits of one cent per pound, as a result of re- 
moving the minimum Federal tax on excess depletion, 
seems quite insignificant, when viewed over the long 
run its significance assumes its proper proportion. It 



has been estimated that approximately 40 million 
metric tons of recoverable copper are contained in the 
33 producing deposits analyzed in this study. If the 
average total cost per pound of production for each of 
these deposits were to decline by one cent it would re- 
sult in a cost reduction of approximately $882 million 
over the total life of these deposits. 

The nonproducing deposits posted an overall decline 
of approximately 10 percent in weighted average total 
cost from repealing the minimum Federal tax. This is 
comparable in magnitude to the increase in cost as a re- 
sult of repealing the percentage depletion allowance. 
Indeed, this recognition of the importance of the mini- 
mum Federal tax as a limiting force to the complete uti- 



TABLE 10. — Economic effects of removing the deple- 
tion limit and minimum Federal tax upon 
producing and nonproducing properties 
within various base case price ranges 



Property 


Number 


Base case 


No depletion 


No minimum 


status 


of 


weighted 


limit 


Federal tax 




properties 


average 


weighted 


weighted 






total cost 


average total 


average total 






per pound' 


cost per 
pound' 


cost per 
pound' 


Producing, 










15-pct ROR: 










to 0.51 .... 


3 


0.401 


0.418 


0.401 


0.51 to 1.26 .. 


25 


1.031 


1.076 


1.021 


1.26 to 2.01 .. 


5 


1.451 


1.457 


1.446 


Nonproducing, 










15-pct ROR: 










to 0.51 .... 


1 


.410 


.400 


.390 


0.51 to 1.26 .. 


9 


1.100 


1.088 


1.070 


1.26 to 2.01 .. 


21 


1.654 


1.643 


1.630 


2.01 to 2.51 . . 


2 


2.143 


2.130 


2.067 


Nonproducing, 










18-pct ROR: 










to 0.51 .... 


1 


.510 


.510 


.490 


0.51 to 1.26 .. 


6 


1.130 


1.100 


1.101 


1.26 to 2.01 .. 


19 


1.596 


1.591 


1.572 


201 to 2.56 . . 


7 


2.211 


2.201 


2.177 



' Weighted average total cost represents the long-run market price per 
pound of copper necessary to cover full costs from all deposits in each 
price range. 



13 



lization of the incentive provided by percentage deple- 
tion has led the American Mining Congress to petition 
for its repeal (73). Although perhaps politically difficult, 
it would be relatively easy administratively to remove 
the so-called excess depletion deduction from the list 



of tax preference items subject to this minimum tax. 
The cost reductions thus generated would significantly 
improve the economics of the nonproducing copper 
properties, ensure wider profit margins, and increase in- 
ternal cash flow. 



CHANGING THE STATUTORY PERCENTAGE DEPLETION RATE ON COPPER 



The first reductions in statutory rates of percentage 
depletion occurred with passage of the tax reform act of 
1969 (19, p. 6). Although the allowance for copper re- 
mained at 15 percent, the rates on a number of associ- 
ated commodities were reduced. As was the case with 
the initial setting of percentage depletion rates on min- 
erals, these reductions bore no relationship to the level 
of imports, domestic reserve position, or criticality of 
the commodities in question to the domestic economy. 

This section quantifies the effects of both a 50-per- 
cent reduction (to 7.5 percent) in the statutory rate on 
copper and a 50-percent increase (to 22.5 percent) in 
order to ascertain the sensitivity of the total depletion 
deduction to the established rate. As before, the results 
are presented on a weighted average total cost basis in 
order to measure the general effect upon the industry. 
Table 11 details these results. 

What is immediately apparent from an examination 
of table 11 is that the most important factor is the provi- 
sion limiting the total percentage depletion deduction 
taken in any given year to 50 percent of before-tax in- 
come. This is clearly demonstrated by the absence of 
change in weighted average total cost for the producing 
properties. A 50-percent reduction in the rate applicable 
to copper effects no change because 7.5 percent of 
gross income in virtually every year is greater than 50 
percent of before-tax income and taxpayers are required 
to deduct the lesser of the two sums. This Jaeing^he 



case, then an increase in the rate applicable to copper 
to 22.5 percent will also be greater than 50 percent of 
before-tax income and result in no change as well. 

The nonproducing properties do show a reduction in 
weighted average total cost in response to an increase 
in the rate on copper. However, the change is quite 
small relative to the size of the increase in the applica- 
ble rate. The 30 properties in the base case price range 
of $0.51 to $2.01 (at the 15-percent level) show a de- 
crease in weighted average total cost per pound of ap- 
proximately $0,005. The reasoning is the same as that 
for current producers; 50 percent of before-tax income 
for almost all years is less than 22.5 percent of gross in- 
come. This is particularly the case with these high cost 
properties. 

Reducing the rate to 7.5 percent would raise the 
weighted average total cost of production for all non- 
producing properties except one, since in this case 7.5 
percent of gross income would be less than 50 percent 
of before-tax income and the taxpayer would then 
deduct the lesser sum. 

The increase in cost itself increases as higher rates 
of return are sought. This is most apparent in the $1.26 
to $2.01 price range where 19 properties, in order to ob- 
tain an 18-percent return on investment, require price in- 
creases of approximately $0,044 per pound as opposed 
to a $0,039 per pound increase for the 21 properties in 
this price range at the 15-percent level. 



TABLE 11. — Economic effects of changing the statutory rate of depletion allowance 
applicable to copper upon producing and nonproducing properties 
within various base case price ranges 



Property 
status 


Number of 
properties 


Base case weighted 

average total cost 

per pound' 


50-pct rate reduction 

weighted average total 

cost per pound 


50-pct rate increase 

weighted average total 

cost per pound 


Producing, 15-pct ROR: 
to 0.51 


3 

25 

5 

1 

9 

21 

2 

1 

6 

19 

7 


0.401 
1.031 
1.451 

.410 
1.100 
1.654 
2.143 

.510 
1.130 
1.596 
1.211 


0.401 
1.032 
1.451 

.410 
1.116 
1.693 
2.162 

.520 
1.141 
1.640 
2.301 


0.401 


0.51 to 1.26 


1.031 


1.26 to 2.01 


1.451 


Nonproducing, 15-pct ROR: 
to 0.51 


.410 


0.51 to 1.26 


1.095 


1.26 to 2.01 


1.650 


2.01 to 2.51 


2.143 


Nonproducing, 18-pct ROR: 
to 0.51 


.510 


0.51 to 1.26 


1.126 


1.26 to 2.01 


1.585 


201 to 2.56 


2.178 







' Weighted average total cost represents the long-run market price per pound of copper necessary to cover full costs from all deposits in each price 
range. 



14 



The importance of this analysis is to underscore the 
point that reduction or increase of the statutory rate it- 
self is less important than the income limitation which 
is placed upon the percentage depletion deduction and 
the provision which stipulates that the lesser of the two 
sums be deducted. Of course, here also, feasibility 



studies performed under the assumption of only a 
7.5-percent depletion rate on copper would render the 
nonproducing properties less economic although cer- 
tainly not to the extent that complete elimination of the 
percentage allowance would. 



CONCLUSIONS 



This study has quantified the minimum long-run de- 
pletion deduction potentially available to the domestic 
copper industry. Based upon constant March 1981 
prices and costs, and assuming a 15-percent return on 
investment, a potential depletion deduction of approxi- 
mately $2.5 billion is available to currently producing 
properties. The nonproducing properties, analyzed 
under similar assumptions, showed a potential avail- 
able depletion allowance of approximately $9 to $12 bil- 
lion accruing over their total producing lives. 

Repeal of the percentage depletion allowance would 
result in a minimum income transfer from the domestic 
copper industry to the Federal Government of approxi- 
mately $1.5 billion for producers and a potential $6 to $8 
billion transfer from nonproducers. 

The weighted average total cost of production for 
both producing and nonproducing properties was 
shown to increase significantly in response to repeal of 
the percentage depletion allowance. In addition, it was 
demonstrated that a 50-percent reduction in the per- 
centage depletion rate applicable to copper would also 
result in a significant increase in average production 
costs for nonproducing properties. For producing prop- 
erties, the statutory rate itself was shown to be much 
less important than the income limitation that is placed 
upon the percentage depletion deduction. Conversely, 
repeal of the minimum Federal tax provision was shown 
to be significant in reducing average production costs 
for both producing and nonproducing deposits. 

It can be concluded that the depletion allowance 
does operate both as a production subsidy and a 
method of capital recovery. However, the fact that a 
mineral producer must have positive before-tax income 
to receive any depletion deduction favors highly profit-* 
able producers over marginal producers. Repeal of the 
percentage depletion allowance to correct this inequity 
would only result in reducing profit margins for all cur- 
rent producers and postponing the eventual- develop- 
ment of currently nonproducing properties. Certainly a 
legislatively induced increase in domestic mining costs 
would result in increased imports and supply vulner- 
ability. Such a repeal would also be undesirable in light 
of the fact that profits, as a percent of sales for the 
domestic mining industry in general, averaged only 5 
percent since 1974 (7, p. 94, 8, p. 359) and current 
Government environmental and safety regulations of 



the copper industry alone are expected to result in cop- 
per price (cost) increases of 43 percent through 1987 (8, 
p. 339). In addition, it has been conservatively estimated 
that cumulative -financing requirements for just the 
domestic copper industry will exceed $20 billion by the 
year 2000 (11, p. 40). 17 

It is important to stress that this analysis has ad- 
dressed the potential size and effect of the income 
transfer from domestic copper producers to the Federal 
Government that could result from repeal of the per- 
centage depletion allowance. But given the increase in 
production costs and the subsequent increase in cop- 
per importation that would result from this repeal, it is 
quite clear that from a national income point of view the 
ultimate income transfer would be from domestic cop- 
per producers to foreign copper producers. The loss of 
domestic mining income and employment and the asso- 
ciated loss in domestic tax revenues that this implies, 
as well as the explicit cost of the additional copper im- 
ports for the U.S. balance of payments, would more than 
offset any gain in corporate income tax revenues that 
the Federal Government may obtain from repealing this 
allowance. 

In addition, there are other benefits from domestic 
copper production, such as the availability of byprod- 
ucts, help in attaining national defense stockpile goals, 
and the assurance of domestic supply which also need 
to be considered. 



Finally, given the importance of the depletion allow- 
ance as a tax provision, consideration should be given 
to redesigning the allowance to more equitably dis- 
tribute the benefits among mining firms and more easily 
administer and account for the cost of the allowance in 
the Government budget while maintaining the incentive 
it provides to the mining industry. This could possibly 
be accomplished by adoption of a per-ton production al- 
lowance. In light of the importance now being placed 
upon mining industry profitability and long-run viability, 
research into such a restructuring of the depletion al- 
lowance is warranted. 



' Certainly all industries need capital and have a claim to tax relief. The 
above points are not intended to down play these concerns nor to set 
the mining industry apart from all others; rather they are intended only 
to underscore the impact of repealing this particular tax provision as it 
applies to the domestic mining industry. 



15 



REFERENCES 



1. Berg, A. W., and F. V. Carrillo. MILS: The Mineral Industry 
Location System of the Federal Bureau of Mines. BuMines IC 
8815, 1980, 24 pp. 

2. Brooks, D. B. (ed.). Resource Economics. Selected works 
of Orris C. Herfindahl, pub. by Resources for the Future, Inc., 
Baltimore, Md., 1974, 316 pp. 

3. Davidoff, R. L. Supply Analysis Model (SAM): A Minerals 
Availability System Methodology. BuMines IC 8820, 1980, 45 
pp. 

4. DeYoung, J. H., Jr., and P. N. Yasnowsky. Capital Forma- 
tion in the Nonfuel Mineral Industries - A Literature Survey. 
U.S. Geol. Survey, January 1980, 56 pp.; available from Na- 
tional Technical Information Service, Springfield, Va., PB 
80-147549. 

5. Feikowsky, S. Taxation and the Depletion Allowance. 
Materials and Society, v. 3, 1979, pp. 209-215. 

6. John W. Whitney, Inc. (Reno, Nev.). Investment and Risk 
Analysis in the Minerals Industry. 1978, 229 pp. 

7. McGraw Hill Publications. Business Week. May 4, 1981, 
178 pp. 

8. . International Minerals/Metals Review. Second 

Edition, 1980, 547 pp. 

9. National Commission on Materials Policy. Material 
Needs and the Environment Today and Tomorrow. June 1973, 
286 pp. 

10. National Commission on Supplies and Shortages. Gov- 
ernment and the Nation's Resources. 1976, 211 pp. 



11. O'Neil, T. J. The Minerals Depletion Allowance: Its Effect 
on Future Supply and Financing. Min. Eng. v. 26, No. 11, 
November 1974, pp. 39-42. 

12. Rosenkranz, R. D., R. L. Davidoff, and J. F. Lemons, Jr. 
Copper Availability — Domestic: A Minerals Availability Sys- 
tem Appraisal. BuMines IC8809, 1979, 31 pp. 

13. Seidman, L. W. Taxation. Am. Min. Cong. J., v. 67, No. 6, 
June 1981, pp. 32-34. 

14. Stermole, F. J. Economic Evaluation and Investment 
Decision .Methods. Investment Evaluations Corp., Golden, 
Colo., 1974, 449 pp. 

15. Tannewald, R. Analysis and Evaluation of Arguments For 
and Against Percentage Depletion. Library of Congress, Con- 
gressional Research Service, March 1978, 60 pp. 

16. U.S. Bureau of Mines. Minerals and Materials/A Monthly 
Survey. August 1980 through March 1981. 

17. . The Bureau of Mines Minerals Availability 

System and Resource Classification Manual. BuMines IC 
8654, 1974, 199 pp. 

18. U.S. Geological Survey and U.S. Bureau of Mines. Princi- 
ples of a Resource/Reserve Classification System for Miner- 
als. U.S. Geol. Survey Circ. 831, 1980, 5 pp. 

19. U.S. Government Accounting Office. Domestic Taxes 
and Minerals Availability: A New Method for Understanding 
Their Relationship. 1980, 139 pp. 







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